Edited version of your private ruling

Authorisation Number: 1012247994425

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Contributions to the Foundation

Question 1:

Are contributions made by the ABC Partnership to the ABC Foundation deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes, to the extent that those contributions are not directed at accumulating corpus of the Foundation.

This ruling applies for the following periods:

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences:

In the year ending 30 June 2013.

Scheme

The ABC Partnership (the Firm) and X Co as trustee of the ABC Service Trust (the Services Entity) employ a large number of employees.

Most staff are dually employed by the Firm and the Services Entity.

The Firm and the Services Entity propose to establish ABC Foundation (the Foundation) for the benefit of the employees and their dependants who are in Necessitous Circumstances or experiencing benevolent needs.

The Foundation is seen by the Firm as a means of enabling them to attract high quality staff and improve staff retention and morale.

The trustee of the Foundation will be a company. The directors of the company will include the partners of the Firm and the senior employees of the Firm and the Service Entity.

A Trust Deed will be executed to establish the Foundation. A separate bank account will be opened in the name of the Foundation.

Clause 3.2 of the Trust Deed states that:

· The Trustee shall apply the Trust Fund for the benefit of such one or more of the Beneficiaries who are in Necessitous Circumstances, or for the benefit of such one or more of the Beneficiaries where the Trustee determines that such events or circumstance have occurred in relation to that Beneficiary or Beneficiaries that but for the application of the Trust Fund the Beneficiary or Beneficiaries would give rise to benevolent needs or financial hardship.

The Trust Deed specifies Beneficiaries as:

· Employees of the Firm and their Dependants; and

· Such Charity or Charities as the Trustee from time to time nominates

Partners and their dependants (including those that would otherwise fall within the class of potential beneficiaries) are excluded from being Beneficiaries of the Foundation.

The Trust Deed also provides the following definitions:

Employee means:

· a person who at the Relevant Time is an employee or Former Employee of the Firm but does not include a person who is or was at any time a partner of the Firm;

Former Employee means:

· A person who was an Employee and whose employment with the Firm ceased no longer than one year prior to the relevant time;

Necessitous Circumstances is defined to mean:

· Financial necessity where a Beneficiary's resources are insufficient to meet a need that would cause hardship resulting in a marked lowering of the Beneficiary's standard of living, including without limiting the foregoing, because of disaster suffered, serious illness, disability or other like situation or event occurring.

Trust Fund means

· the Initial sum; and

· all the cash, investment and other property for the time being held by the Trustee on the trusts of this deed, including without limitation property or assets acquired by:

· the transfer of property as an addition to the Trust Fund;

· purchase or by the exercise of the Trustee's powers of investment, including its power to borrow money for the purposes of the Trust Fund; or

· the accumulation of the income of the Trust

The Foundation continues in operation until the Termination Date, which will be the Vesting Date or such earlier date as may be determined by the Trustee in its absolute discretion. The Vesting Date means the day immediately preceding the 80^th anniversary of the Commencement date.

Prior to the Termination Date the Trustee may advance any part of the capital of the Trust Fund towards the purposes of the Foundation provided it does not distribute the whole of the Trust Fund.

In the event the Foundation is wound up, any remainder assets will be distributed to the Beneficiaries in Necessitous Circumstances or with benevolent needs, which include the charitable entities if there are no relevant individual Beneficiaries who are otherwise entitled to a share of the trust asset at that time.

The Trustee may add to, vary, delete or revoke any of the provisions of the Trust Deed, including provisions which confer powers, authorities and discretions of the Trustee, except that any such addition, variation, deletion or revocation must not:

· derogate from any vested interest in the Trust Funds or Income;

· enlarge the class of persons capable of falling within the definition of Beneficiary;

· extend the Vesting Date ; or

· vary the nature of the trusts created by the Trust Deed.

Contributions to the Foundation are to be made by the Firm and the Services Entity as employers and are irretrievable to those entities. To the extent the Firm pays the contribution through the Services Entity no mark up will be included as described in Taxation Ruling TR 2006/2. The contribution will be invested on an arm's length basis with unrelated third parties and will not be directly or indirectly available to the Firm or the Services Entity.

Contributions are to be made on an on-going basis and will form part of the corpus of the Foundation and continue to be made until an appropriate level of funding commensurate with the Foundation's objectives is achieved.

There is an aspirational target to accumulate a corpus over the next 5 years from contributions to and accumulated taxed income of the Foundation. 

Distributions from the Foundation will be made depending on the particular circumstances of the eligible Beneficiary, the funds available for distribution, and according to the terms of the Trust Deed. 

The Foundation will be listed as one of the benefits available to eligible employees on the Firm's intranet, weekly newsletter and is intended to be promoted in the recruitment of new staff.

Income derived by the Foundation from investment of its corpus will be accumulated in the Foundation and subject to tax in the hands of the trustee under section 99A of the Income Tax Assessment Act 1936.

Relevant legislative provision

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Section 8-1 of the ITAA 1997 provides that:

You can deduct from your assessable income any loss or outgoing to the extent that:

· it is incurred in gaining or producing your assessable income; or

· it is necessarily incurred in carrying on a business for the purpose of producing your assessable income.

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

…..

Broadly, the provision provides an entitlement to a deduction from assessable income for any loss or outgoing, to the extent that it is incurred in gaining or producing your assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

However, subsection 8-1(2) of the ITAA 1997 (so far as it is relevant) prevents such a deduction to the extent that it is a loss or outgoing of capital, or of a capital nature.

Losses or outgoings to the extent that it is incurred in gaining or producing your assessable income; or it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

The Firm provides irretrievable cash contributions directly to the Foundation, or through the Services Entity to be used in accordance with the Trust Deed. The contributions made by the Firm will be considered to be losses or outgoings for the purpose of subsection 8-1(1) of ITAA 1997.

The Partners of the Firm have identified their motivation for the establishment of the Foundation is to generate goodwill among employees, promote loyalty to the Firm and attract high quality staff. Consistent with this motivation is the proposal to list the Foundation as one of the benefits available to eligible employees on the Firm's intranet and is intended to be promoted in the recruitment of new staff. The Foundation is seen by the Firm as adding to and enhancing its reputation as an employer of choice and demonstrates that it accepts and embraces its social obligations and responsibilities as a large employer.

The purpose of the Foundation is set out in the Trust Deed. The Trust Deed requires the Trust Fund to be applied for the benefit of employees and their dependants, and specifically excludes Partners of the Firm from benefiting. The purpose is clearly for the benefit of employees and recent former employees.

Upon termination, the surplus of the Trust Fund may be distributed to charities. We consider this to be a minor or incidental feature of the Trust Fund and consequently it does not detract from the main purpose being for the benefit of employees and recent former employees.

Taxation Ruling TR 95/33 provides guidance on the relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings. Paragraphs 37 of the Ruling refers to the comments of Deane and Fisher JJ in Magna Alloys & Research Pty Ltd v. FC of T, 80 ATC 4542 (at 80ATC 4559):

The controlling factor is that, viewed objectively, the outgoing must, in the circumstances, be reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income. Provided it comes within that wide ambit, it will, for the purposes of s.51(1) be necessarily incurred in carrying on that business if those responsible for carrying on the business so saw it.'

Applying the quote in TR 95/33 to these facts, the outgoing is reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income. Having regard to the taxpayer's subjective purpose, to generate goodwill amongst employees, it is considered that these outgoings are necessarily incurred in carrying on the business. Therefore in accordance with TR 95/33, the outgoing meets the requirement of being necessarily incurred in carrying on that business under subsection 8-1(1) of the ITAA 1997.

Loss or outgoings of capital, or of a capital nature

Subsection 8-1(2) of the ITAA 1997 (so far as it is relevant) prevents a deduction to the extent that it is a loss or outgoing of capital, or of a capital nature.

Whether expenditure is capital in nature is determined on the facts of each particular case having regard to the principles established by the case law. The ATO recently restated longstanding principles concerning the capital versus revenue distinction in Taxation Ruling TR 2011/6. Paragraphs 66-68 of TR 2011/6 state:

66. The classic test for determining whether expenditure is of a capital or revenue nature is explained in the following passage from the judgment of Dixon J in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 23; (1938)1 AITR 403 ( Sun Newspapers):

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay...

67. The character of the advantage sought provides important direction. It provides the best guidance as to the nature of the expenditure as it says the most about the essential character of the expenditure itself. This was emphasised in the decision of the High Court in G.P. International Pipecoaters v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1.

68. If expenditure produces some asset or advantage of a lasting character for the benefit of the business it will be considered to be capital expenditure. As stated in Sun Newspapers at 355 per Latham J, an enduring benefit does not require that the taxpayer obtain an actual asset, it may be a benefit which endures, in the way that fixed capital endures. Menzies J in John Fairfax & Sons Pty Ltd v. Federal Commissioner of Taxation (1959) 101 CLR 30; (1959) 11 ATD 510; (1959) 7 AITR 346 concluded that a capital expense can also result in the reduction of capital. In Foley Brothers Pty Ltd v. FC of T (1965) 13 ATD 562; (1965) 9 AITR 635, outgoings incurred for the purpose of altering the organisation or structure of the profit-yielding subject (including its demise) were considered to be of a capital nature.

In this case the contributions to be made to the Foundation, at least during the first five years of operation, are intended and expected to serve two separate purposes. The first purpose is to fund the recurrent (or anticipated recurrent) outgoings of the Foundation in providing benefits to employees. The second purpose is to accumulate a target corpus amount.

On the question of whether the contributions were revenue or capital in nature, Hill J in Walstern v. Federal Commissioner of Taxation 2003 ATC 5076 at 5090 stated:

However it cannot be said that the question whether a payment is a one-off payment or whether it is a recurrent payment is a matter irrelevant to whether the outgoing is capital. In a case such as the present where the payment operates to create the capital of a trust fund the outlay will ordinarily be seen as capital both because of the lasting qualities enjoyed and the fact that what is being made is a final payment to secure future benefits. However, if a contribution is one of a number of 'recurrent' contributions for employees, so that it can be seen to be part of the ordinary flow of business expenditure of a taxpayer, the character of the outlay will take on a different complexion.

To the extent that contributions to the Foundation can reasonably be seen as serving the first purpose, we consider that those amounts will be revenue in nature. The amounts will be recurrent, and will not have the kind of lasting benefit to the business referred to in TR 2011/6.

The next question to consider is whether any part or all of the contribution applied to serve the second purpose is of capital in nature.

You have stated that there is an aspirational target to accumulate a corpus over the next five years. We consider that the accumulation of corpus funds in the Foundation is an integral part of creating the goodwill, loyalty and attraction to staff in relation to employment with the Firm as it provides a degree of confidence that the promoted benefits are genuinely available and funded. The accumulation of the corpus provides an advantage of a lasting character for the benefit of the business as referred to in paragraph 68 of TR 2011/6.

Furthermore, the corpus in the Foundation will be invested by the trustee and the income from investment will form part of the Trust Fund available to meet the objects of the trust. The contributions directed at accumulating the target corpus serve the purpose of generating ongoing funds which meet, or partially meet, the recurrent outgoings of the trust. This also strongly points towards the enduring benefits referred to in TR 2011/6.

Accordingly, to the extent that contributions to the Foundation can reasonably be seen as directed at accumulating the corpus, we consider that those amounts will be capital in nature.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).