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Ruling

Subject: carrying on a business

Question

Will the taxpayer's participation in the Managed Investment Scheme (MIS) constitute the carrying on of a business?

Answer

Yes.

This ruling applies for the following period:

1 July 2012 to 30 June 2013

The scheme commences on:

The scheme has not yet commenced.

Relevant facts and circumstances

Overview and Background

The taxpayer is contemplating becoming an investor in a managed investment scheme (MIS).

The taxpayer proposes to acquire assets for participation in the aspect of the business which involves producing output. Other parties will be appointed by the Investors to operate other aspects of the MIS.

In order to proceed, the MIS will need to be fully subscribed. The offer to the public will have an open and close date during which time each investor's application form will be processed and application money committed and paid. The application money will be held in a trust bank account until the end of the offer period in accordance with the Corporations Act 2001. If at the end of the offer period it is determined that the total minimum subscription is reached, the MIS will proceed. If the minimum subscription is not reached then the MIS will not commence and the Investors will be refunded their application money.

As part of their participation in the MIS, the taxpayer proposes to acquire a minimum interest. Each interest comprises an asset and various rights.

The investors will appoint the Responsible Entity (RE) who will be responsible for a number of aspects of the MIS, including pooling the collection of their output, ongoing servicing and maintenance of the plant, and sale of output. The RE will appoint a manager, as subcontractor, to undertake a large component of this role.

The investors will be granted a licence which allows them the right to use and access the plant. The RE will enter into the lease in respect of the plant with the plant company and the investors' ownership rights will be represented by their proportionate interest in the MIS.

The assets will be chattels at law and the investors can remove them from the MIS on the giving of reasonable notice to the RE. The assets are expected to have a useful life of 25 years, which is equivalent to the term of the MIS. The plant company will own the right to the land on which the assets and plant are located and will grant access to the RE under the lease. With this access, the constitution will also contain a clause which grants the investors a license to access and use the land on which their assets are located.

The investors will appoint the RE to manage their business, with the RE being responsible for operating, maintenance and sales functions.

The key business activities to be carried out for the investors by the RE will be prescribed under the MIS constitution and will fall under two main categories:

· operation and maintenance (O&M) and

· sales

The RE will appoint the manager to undertake a large component of the above functions. The manager will undertake these functions in its capacity as subcontractor and, in this regard, the RE remains ultimately responsible for the performance of these functions.

According to the constitution, the investors' entitlements to net sale proceeds will be distributed by the RE to the Investors in proportion to the number of assets they own.

The manager, RE and any other related entities will not be specifically prohibited from holding interests in the MIS. These interests will carry the same terms as those of the investors, to the extent permitted by law. The constitution will not set a maximum limit to the number of interests that may be held by these entities. However, there are limitations imposed by the Australian Prudential Regulation Authority as to the maximum percentage interest in a MIS that can be held by an "Extended Licensed Entity" (currently 20%).

Business cash flows

Once accepted into the MIS, the taxpayer intends to participate via the acquisition of minimum number of interests in the MIS, with each interest representing one asset.

Each year from commencement of the MIS, the RE will be responsible for collecting and depositing into each investor's segregated account the net sale proceeds from the sale of output. The determination of the net sale proceeds available for distribution will be made by the RE. Investors will have a continuing financial commitment to the MIS and in return will be entitled to receive income from the sale of output.

The investors will elect upfront that the final output may be sold on a pooled basis together with the output of the other investors. Investors may elect to withdraw their output from the pooling arrangements by providing sufficient notice of their intention to the RE, in which case, they will also be deemed to have elected to remove their assets from the MIS and their interest in the MIS will be rescinded.

The MIS documents

It is proposed that the relevant MIS be governed inter alia by the following primary documents:

constitution

retail sale agreement

management agreement

sub-management agreement (with sub contractors)

lease agreement

irrevocable power of attorney, and

product disclosure statement (PDS).

PDS

The MIS will be registered by the Australian Securities and Investments Commission (ASIC) as a registered managed investment scheme prior to the issuance of the PDS. The RE that is ultimately appointed will hold the appropriate Australian Financial Services Licence issued by ASIC.

Interests in the MIS can only be obtained by the taxpayer completing the application form attached to the PDS and as part of the application the taxpayer also executes the power of attorney, which will allow the RE to enter into and execute on his behalf the retail sale agreement and the management agreement. Once interests are issued to the taxpayer, he will be bound by the constitution which gives the RE the power to make certain decisions on behalf of the taxpayer relating to the conduct of the MIS.

Lease Agreement

Once the project is fully subscribed, the plant company, on behalf of the RE, will at its own cost, procure the rights to the land, construct the necessary infrastructure, install the assets, and carry out any capital works to bring the MIS to the point of operation and commission. The plant (including the land or rights to the land) will remain the property of the plant company.

The above agreement will be drafted into the Lease in respect of the plant, which will be executed by the RE in its capacity as RE of the MIS immediately prior to the commencement of the MIS.

Management Agreement

The RE will, following the issue of interests, enter into the management agreement in its capacity as RE of the MIS and as attorney for the investors. The management agreement will set out the responsibilities of the RE which include the O&M functions and the overarching function of ensuring the MIS is fully operational at all times. The management services may also include some element of the sales function. It will also set out the rights of the RE, including access rights and basis of consideration for functions performed.

It is important to note that the RE in its capacity as RE of the MIS will have the power to remove the manager in the event there is a breach of any clause of the sub-management agreement (or otherwise) by serving a notice on the manager. In the event the manager is removed, the manager agrees to transfer its rights and responsibilities under the management agreement to the new manager.

The Constitution

The constitution will be executed by the RE and will be in accordance with the requirements of Chapter 5C of the Corporations Act 2001.

The key functions of the RE will be outlined in a schedule to the constitution and the management agreement.

The Constitution will also include a provision which confirms that the relationship between each investor and also between each investor and the RE and manager is not intended to be treated as a partnership at law. Nor is it intended to be treated as a limited partnership, unit trust, joint venture, limited company or association. The relationship between each investor should not be taken to be contractual.

The Investors will have the power to call meetings of the MIS and in certain circumstances to require the RE to undertake certain actions.

Assumptions

The taxpayer intends to participate via the acquisition of a minimum interest in the MIS.

The taxpayer will enter into the relevant MIS during the initial offer period and will continue his involvement in the MIS until its completion.

The manager and RE are unrelated entities and acting at arm's length.

The function of installing the assets to the plant will be delegated by the RE to the plant company.

There will be an adjustment towards the end of each income year to reconcile any under/over payment of operating and maintenance fees.

Prior to commencement of the MIS, an engineering firm will undertake a profile of the site and provide an independent, detailed report which attests the viability and appropriateness of the site. The project will not commence without such a report.

The documents and agreements referred to in this ruling will be executed and will enable the conduct of the MIS as described in the facts contained in this ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 328-110(1)(a)

Reasons for decision

The indicators of conducting a business have frequently been identified by the courts in cases such as:

· Sun Newspapers Ltd and Associated Newspapers Ltd v The Federal Commissioner of Taxation (1938) 61 CLR 337

· Ferguson v Federal Commissioner of Taxation (1979) 37 FLR 310

· Puzey v Commissioner of Taxation (2003) 131 FCR 244

The Commissioner has considered these indicators as set out in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? Whilst the business in question does not involve that of 'primary production', the principles established by the Commissioner in TR 97/11 are equally relevant to the business of renewal energy generation.

Paragraph 18 of TR 97/11 summarises the main indicators of carrying on a business as being:

· a significant commercial activity

· purpose and intention of the taxpayer in engaging in the activity

· an intention to make a profit from the activity

· the activity is or will be profitable

· repetition and regularity of activity

· activity is carried on in a similar manner to that of the ordinary trade

· activity organised and carried on in a businesslike manner and systematically - records are kept

· size and scale of the activity

· not a hobby, recreation or sporting activity

· a business plan exists

· commercial sales of product

· taxpayer has knowledge or skill

No one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922), and there is often a significant overlap of these indicators. Furthermore, the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884).

Significant commercial purpose

The taxpayer will be one of a number of investors engaged in a commercial activity of a meaningful size and scale.

The RE will be appointed by the investors to undertake the day to day activities required to install, operate and maintain the MIS. The RE will then enter into a sub-management agreement on behalf of the investors under which it will delegate a number of these functions to the manager.

In addition to this, the RE will also negotiate the sale of the output.

The manager will provide periodic (at least annual) reporting to the RE on the performance of the MIS in terms of operational and financial performance (both on a retrospective and prospective basis) and the RE will make available the content of these reports to the Investors.

Taxpayer's purpose of profit

There is little doubt that the taxpayer will participate in the MIS for the purpose of deriving financial gain. However, such a gain will only be derived if proceeds from the sale of output exceed the expenses incurred in producing it. The taxpayer will also have an ongoing commitment to pay management fees and other outgoings so as to ensure that the MIS remains commercially productive. This activity will extend over 25 years and be performed by the RE or manager, but at the expense of the taxpayer, such expenses being met from year to year. There will be financial returns, commencing from the first full financial year.

The taxpayer is expected to derive revenue from the date that his/her assets are installed ready for use. The MIS will generate output for sale from the first day it is operational and sales revenue is expected to grow over time.

Revenue and budget forecasts for the MIS will be prepared and presented to the investors under the annual reporting process. The annual reporting will also include updates on operational performance of the MIS and a marketing plan for the coming year.

Repetition and regularity

Once the MIS is operational, output will be continuously generated, and sold. Other regular and repetitious business activities will include the regular maintenance of the assets for the 25 year life of the MIS. The RE will appoint the manager, an expert in the field of the relevant business activity, to undertake the O&M function and some of the sales function.

The taxpayer will have an ongoing commitment to pay fees and outgoings so as to ensure that the MIS becomes, and remains, commercially productive. O&M functions and the sales function will extend over 25 years and be performed by the RE or its agent, but at the expense of each investor, including the taxpayer.

Carried out in a manner consistent with other similar projects

The MIS is to be organised and carried on in a businesslike manner and systematically.

The manager will maintain regular accounts of the costs and revenue of the MIS and will report (at least annually) to the RE on the financial and technical performance of the MIS, which will be made available to the investors under the annual reporting process. The investors and the RE will operate the MIS in a commercial and professional manner, similar to other MIS, and will not treat it as a hobby, recreation or sporting activity.

At the time of the establishment of the MIS the RE will submit a business plan to the investors which will describe how the MIS is to be managed including a schedule for O&M, regular management of equipment warranty/guarantee rights and detailed marketing plans for maximising revenues from output.

The RE will also report on at least an annual basis to investors as to the technical and financial performance of the MIS.

Organised in a businesslike manner

The land owner of the MIS site has agreed in principle to lease the site to the plant company.

The MIS will be operated in an organised and systematic manner, according to the business plan and MIS documents. For example, the operation and maintenance function will be undertaken according to a prescribed maintenance schedule, the sales will be handled in a commercial and professional basis, and any other activities undertaken by the manager will be undertaken pursuant to the contractual obligations prescribed under the formal sub-management agreement.

The MIS will be governed inter alia by the following primary documents:

constitution,

retail sale agreement,

management agreement,

sub-management agreement (with sub contractors),

lease agreement,

irrevocable power of attorney, and

product disclosure statement.

Each investor will have obligations under the management agreement and constitution but will look to the RE to perform most of those functions and will pay for such performance and ultimately bear the consequences of any failure by the RE (or delegated manager) to do so.

Size or scale

This is a large scale MIS in which the taxpayer is proposing to participate.

Other indicators

There will be commercial sales of product.

The taxpayer may not have sufficient knowledge or skill to operate a MIS. However, an engineering expert is being employed to, among other things; undertake a profile of the proposed MIS site. This is broadly an assessment of the viability and appropriateness of the site. Furthermore, prior to confirming the site, a reputable engineering firm will be engaged to provide an independent, detailed report which attests the viability and appropriateness of the chosen site.

Thus, application of the principles contained in TR 97/11 to the MIS, leads to the large or general impression that investors in the MIS are considered to be carrying on a business.

Hance v. FC of T; Hannebery v. FC of T (Hance) [2008] FCAFC 196; 74 ATR 644; 2008 ATC 20-085.

Where agreements entered into are of a similar nature to those entered into by the taxpayers in Hance and similar features are present in the MIS arrangement, it is likely to be concluded that a business is being carried on.

In Hance, the Full Federal Court found that, under the particular MIS, investors would be carrying on a business and therefore upfront payments for rent, management fees and other charges would be deductible. The court considered it important in this case that the production of almonds would take place over an extended period of approximately 23 years; the work was repetitive and would be paid for on a regular basis; and returns would be received year by year in the form of almonds.

In reaching its decision, the Full Federal Court also considered retention of ownership by individual members, of the produce of the MIS, to be of importance. The Court held that, up until their sale, the applicants would retain such ownership, which would extend to them being able to withdraw their almonds from any pooling arrangement up until the point of sale.

The Court also found that "a person who conducts a business may delegate functions to another". This is also supported by the decision in Puzey which held that "it is not necessary in concluding that a business is carried on that the acts to be undertaken are acts of the person seeking to establish he or she is carrying on a business. So a person may appoint another to take the steps which constitute the business activity". In relation to the pooling of the almonds, the court stated:

"This MIS, allowing both for pooling and for the easy ascertainment of a grower's entitlement on sale, seems to us to reflect no more than a commercially sensible mechanism which, it is probably envisaged, will be fair and economical to all growers in the circumstances."

Each investor will have obligations under the management agreement and constitution but will look to the RE to perform most of those functions and will pay for such performance and ultimately bear the consequences of any failure by the RE (or delegated manager) to do so. Under the constitution or the Corporations Act 2001, the investors will be provided with at least annual reporting, and will have the ability to call a meeting of MIS members to address any concerns about the performance of the business. In certain circumstances they will have the ability to remove the RE and/or manager.

In this MIS, the taxpayer will elect upfront that the final output may be pooled with that of the other investors and collectively marketed and sold. In this context it is relevant to note the Court's finding in Hance's case that participating "in pooled marketing and sales may well be an entirely appropriate way of carrying on a business". In the context of a MIS, it is also the most efficient and cost effective sales and marketing strategy and also ensures that all Investors access the benefits of scale. The investors have the ability to withdraw their output from the pooling arrangements by providing sufficient notice of their intention to the RE, in which case, they will also be deemed to have elected to remove their assets from the MIS (and their interest in the MIS will be rescinded).

This MIS shares the following additional similarities with the MIS in Hance:

· production of output will take place over an extended period of 25 years,

· work to be done in the MIS will include regular repetitive maintenance,

· returns will be received continually in the form of output, and

· investors will own the assets which produce their share of saleable output,

· investors have the right to withdraw their output and assets from the MIS.

Thus, the principles in Hance can be applied to conclude that investors in the MIS are considered to be carrying on a business. The investors business will commence at the time of execution of their lease and management agreement.

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