Edited version of your written advice

Authorisation Number: 1012728207887

Ruling

Subject: Income Injection Test

Question 1

Is the income injection test in subsection 270-10(1) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) failed?

Answer

No. It is not reasonable to conclude that the scheme assessable income was derived, or that certain benefits were provided, wholly or partly, but not merely incidentally because of the deductibility of a tax loss of the Trustee.

This ruling applies for the following periods:

1 July 20XX to 30 June 2015

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust was established on 1 July 20XX to carry on the business of acquiring, developing and selling residential land.

The Trust is not a 'fixed trust' for the purposes of section 272-65 of Schedule 2F to the ITAA 1936

The Trustee has carried forward tax losses in respect of the Trust.

The Trustee has not made a family trust election in respect of the Trust for the purposes of section 272-80 of Schedule 2F to the ITAA 1936.

The Trust is not an excepted trust for the purposes of section 272-100 of Schedule 2F to the ITAA 1936.

The Unitholders in the Trust have been the same since it was established:

Further Units have not been issued since the establishment of the Trust.

It is proposed to issue further Units to the existing Unitholders in proportion to their current Unitholdings.

Land sales have been slow.

Due to the high debt levels, interest expenses have eroded the profitability of the project significantly.

Trust equity has been eroded significantly to the point where banking covenants in relation to loan to asset ratios may be breached.

To improve profitability, and to avoid defaulting on its loans, the Trustee plans to replace some bank debt with further equity.

The Trustee will call for additional equity subscription from its Unitholders.

All Unitholders will subscribe for additional equity at market value pro rata to their existing capital.

This will provide equity capital for the Trustee to repay interest bearing debt.

It is anticipated that all Unitholders in the Trust will contribute additional equity in proportion to their existing Unitholdings so that there will be no change in underlying beneficial ownership.

Company owns all of the Units in a Unitholder of the Trust and will make an interest free loan to the Unitholder to enable that Unitholder to subscribe for additional Units in the Trust.

Company has at all times owned the units in that Unitholder and will maintain ownership of those Units throughout the ruling period.

An arrangement will not exist enabling any Unitholder, or associate of a Unitholder, to benefit from the tax losses.

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 section 270-10

Income Tax Assessment Act 1936 section 270-20

Income Tax Assessment Act 1936 section 270-25

Income Tax Assessment Act 1936 section 270-65

Income Tax Assessment Act 1936 section 272-80

Income Tax Assessment Act 1936 section 272-140

Income Tax Assessment Act 1936 section 318

Reasons for decision

Summary

As paragraph 270-10(1)(c) of Schedule 2F to the ITAA 1936 is not satisfied each of the paragraphs in subsection 270-10(1) are not satisfied. Therefore, the income injection test in section 270-10 is not failed in respect of the proposed Scheme.

Detailed reasoning

Subsection 270-10(1) of Schedule 2F to the ITAA 1936 provides that:

270-10(1)

The consequences set out in section 270-15 result if:

(a) a deduction is allowable to a trust for the income year; and

(b) under a scheme, the following happen (in any order):

(i) the trust derives an amount of assessable income (the scheme assessable income) in the income year; and

(ii) an outsider to the trust (see section 270-25) directly or indirectly provides a benefit (see section 270-20) to the trustee, to a beneficiary in the trust or to an associate of the trustee or of a beneficiary; and

Note: The benefit may constitute all or any of the scheme assessable income.

(iii) the trustee, a beneficiary in the trust or an associate of the trustee or of a beneficiary, directly or indirectly provides a benefit to the outsider to the trust or to an associate of the outsider (other than an associate covered by any of paragraphs 270-25(1)(a) to (f); and

Note: The benefit may constitute all or any of the deduction.

(c) it is reasonable to conclude that:

(i) the trust derived the scheme assessable income; or

(ii) the outsider provided the benefit as mentioned in subparagraph (b)(ii); or

(iii) the trustee, beneficiary or associate provided the benefit as mentioned in subparagraph (b)(iii);

wholly or partly, but not merely incidentally, because the deduction would be allowable; and

(d) the trust is not an excepted trust under paragraph 272-100(b), (c) or (d).

In order for the income injection test to be failed each of the four paragraphs (270-10(1)(a), (b), (c) and (d) of Schedule 2F to the ITAA 1936) must be satisfied.

Paragraph 270-10(1)(a) of Schedule 2F to the ITAA 1936

Deduction: The carried forward tax loss deductions available to the Trustee satisfy the requirement that there be a deduction.

Therefore, paragraph 270-10(1)(a) of Schedule 2F to the ITAA 1936 is satisfied.

Paragraph 270-10(1)(b) of Schedule 2F to the ITAA 1936

Scheme: Subsection 272-140(1) of Schedule 2F to the ITAA 1936 provides that 'scheme' has the same meaning as subsection 177A(1) of the ITAA 1936. Subsection 177A(1) defines the term 'scheme' as:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

In relation to the facts at hand, the proposed course of action to partially or fully replace bank debt with equity satisfies the definition of being a scheme.

• Under a Scheme: In relation to this term, the Tribunal in Re Eldersmede Pty Ltd and Federal Commissioner of Taxation [(25 June 2004) - [2004] AATA 710; (2004) 2004 ATC 2129; (2004) 56 ATR 1179; [2005] ALMD 1375; [2005] ALMD 1385 - Administrative Appeals Tribunal] (Eldersmede) noted that (at 69):

The authorities to which we have referred indicate that, in various contexts, the word "under" in the expression "under a scheme" in s. 270(10)(1) of the ITAA 1936 may mean "pursuant to", "in accordance with", "provided for in", "by virtue of", "authorised or required by", "directly effected by" or "through the operation of, as a matter of legal effect"…What is common to all of these authorities is that there must be a sufficient nexus or connection between two matters so that one may be said to be under the other or to have occurred under the other…In the context of the case that we must consider, the two aspects have been identified. They are the happenings identified in s. 270-10(1)(b)(i), (ii) and (iii) on the one hand and the scheme on the other. However it is described, the connection, nexus or link between each of the happenings and the scheme must be such that the happening can be said to have been under the scheme. That is to say, the happening is not merely, for example, a remote "spin off" of a step that has itself been taken under the scheme.

Subparagraph 270-10(1)(b)(i):

Scheme assessable income: The income is earned by the Trustee as the land is sold. As such, there is scheme assessable income.

Subparagraph 270-10(1)(b)(ii):

Outsider provides a benefit:

• Outsider to the Trust: Subsection 270-25(2) provides that an outsider to a non-family trust is a person other than:

(a) the trustee of the trust; or

(b) a person with a fixed entitlement to a share of the income or capital of the trust.

It has been noted that:

• a family trust election has not been made in respect of the Trust for the purposes of section 272-80 of Schedule 2F to the ITAA 1936; and

• the Trust is not a fixed trust for the purposes of section 272-65.

As such, all persons, apart from the Trustee are outsiders to the Trust.

• Benefit: Section 272-20 of Schedule 2F to the ITAA 1936 provides that a 'benefit is:

(a) money, a dividend or property (whether tangible or intangible); or

(b) a right or entitlement (whether or not property); or

(c) services; or

(d) the extinguishment, forgiveness, release or waiver of a debt or other liability; or

(e) the doing of anything that results in the derivation of assessable income; or

(f) anything that, disregarding the preceding paragraphs, is a benefit or advantage.

In Eldersmede the Tribunal found that, in relation to the meaning of the term 'benefit' (as defined in section 272-20), that:

• It should be given a broad meaning (at 36);

• The words "benefit or advantage" should be given their ordinary meanings (at 40); and

• Whether or not a benefit has been provided must be assessed objectively (at 41).

• Directly or Indirectly: In Eldersmede the Tribunal found that (at 46):

… the expression "directly or indirectly" requires first an examination of the outcome that is qualified by the expression and then the proximate and contributory causes of that outcome. In the context of s. 270(1)(b)(iii), the outcome that is qualified by the expression is the provision of a benefit. The question then becomes whether SBS, as trustee of CUT, was the proximate or a contributory cause of the provision of a benefit to Eldersmede, as trustee of EDT, or to an associate of Eldersmede, as trustee of EDT. There is no need for SBS to have itself provided a benefit provided it contributed to the provision of that benefit in some way and even though there may be other factors or actions contributing to the provision of the benefit. If it was either the proximate cause or a contributory cause, it will be taken to have provided that benefit directly or indirectly. There is no need to go further and to characterise whether it was direct or indirect; it was one or the other.

• Associates:

• Subsection 272-140(1) of Schedule 2F to the ITAA 1936 also provides that: 'associate' has the same meaning as in section 318 of the ITAA 1936;

• Section 318 of the ITAA 1936 sets out those who are regarded as the 'associates' of a natural person, company, trustee, partnership and public unit trust entity.

• Section 318(3) relating to the associates of a trustee is relevant in this case and it provides:

For the purposes of this Part, the following are associates of a trustee (in this section called the 'primary entity'):

(a) any entity that benefits under the trust;

(b) if a natural person benefits under the trust - any entity that, if the natural person were the primary entity, would be an associate of the natural person because of subsection (1) or because of this subsection;

(c) if a company is an associate of the primary entity because of paragraph (a) or (b) of this subsection - any entity that, if the company were the primary entity, would be an associate of the company because of subsection (2) or because of this subsection.

• 318(6) provides that the term 'benefits under a trust' means:

a reference to an entity benefiting under a trust is a reference to the entity benefiting, or being capable (whether by the exercise of a power of appointment or otherwise) of benefiting, under the trust, either directly or through any

interposed companies, partnerships or trusts;

Under the scheme, an outsider to the Trust directly or indirectly provides a benefit to a beneficiary (i.e., when Company provides the interest free loan to the Unitholder in the Trust).

Subparagraph 270-10(1)(b)(iii):

Trustee, beneficiary or associate provides a benefit:

Under the scheme, the trustee, a beneficiary in the trust or an associate of the trustee or of a beneficiary, directly or indirectly provides a benefit to the outsider (Company) to the trust or to an associate of the outsider as the Trustee and the Unitholder will provide higher distributions than would otherwise be the case, which will be paid down the ownership line.

Conclusion: As each of subparagraphs 270-10(1)(b)(i), (ii) and (iii) of Schedule 2F to the ITAA 1936 are satisfied, paragraph 270-10(1)(b) is satisfied.

Paragraph 270-10(1)(c) of Schedule 2F to the ITAA 1936

Reasonableness

n Objective not subjective: The Court in Corporate Initiatives Pty Ltd v. Commissioner of Taxation [(28 April 2005) - (2005) 219 ALR 339; [2005] FCAFC 62; (2005) 2005 ATC 4392; (2005) 59 ATR 351; [2005] ALMD 6708; [2005] ALMD 6709; [2005] ALMD 6710; (2005) 142 FCR 279 - Federal Court of Australia] (Corporate Initiatives) and the Tribunal in Eldersmede noted that any 'subjective' intention of a relevant person is not relevant and that an objective purpose is to be ascertained by having regard to objective facts: Peabody v Commissioner of Taxation (1993) 40 FCR 531 at 542, Eastern Nitrogen Ltd v Commissioner of Taxation (2001) 108 FCR 27 at [81]. (at 18)

The Court in Corporate Initiatives also noted that:

In addition to the authorities already mentioned, in Commissioner of Taxation v Hart (2004) 206 ALR 207 at [37] Gummow and Hayne JJ pointed out that the statutory definition in s 177A requires "an objective, not subjective, inquiry". In the Explanatory Memorandum (par 10.2) it is said that the income injection test

"…operates objectively and does not have a tax avoidance motive as one of its elements." (emphasis in original) (at 27)

Conclusion: It is not reasonable to conclude that:

(i) the trust derived the scheme assessable income; or

(ii) the outsider provided the benefit as mentioned in subparagraph (b)(ii); or

(iii) the trustee, beneficiary or associate provided the benefit as mentioned in subparagraph (b)(iii);

wholly or partly, but not merely incidentally, because the deduction would be allowable;

as:

• The driving motivation for the scheme is to replace debt with equity in the Trust so that profitability improves and loan to asset ratio requirements on bank loans are not breached;

• The Unitholders in the Trust have been constant and further Unitholders will not be introduced as a part of the proposed scheme;

• All equity participants will retain the same pro rata equity;

• Company will not gain any additional rights to the income or capital of entities involved as a result of it making the interest free loan to the Unitholder;

• An arrangement will not exist enabling Company to benefit from the tax losses in respect of it making the interest free loan;

• The existence of the tax losses in the Trust is incidental to the existence of the financial problems of the Trust which are hoped will be addressed by the implementation of the scheme.

• Therefore, paragraph 270-10(1)(c) of Schedule 2F to the ITAA 1936 is not satisfied.

Paragraph 270-10(1)(d) of Schedule 2F to the ITAA 1936

Excepted trust

Section 272-100 of Schedule 2F to the ITAA 1936 defines the term 'excepted trust' as:

A trust is an excepted trust at a particular time if:

(a) it is a family trust at the particular time; or

(b) it is a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the income year in which the particular time occurs; or

(c) it is the trust of a deceased estate, where the particular time occurs during the period from the death of the individual until the end of the year of income in which the 5th anniversary of the death occurs; or

(d) at the particular time it is a fixed trust that is a unit trust, and persons all of whose income is exempt from tax under section 23, or under Division 50 of the Income Tax Assessment Act 1997, have fixed entitlements, directly or indirectly, and for their own benefit, to all of the income and capital of the trust." (ss. 272-140 and 272-100)

Conclusion: The Trust is not an excepted trust, therefore, paragraph 270-10(1)(d) of Schedule 2F to the ITAA 1936 is satisfied.

Overall conclusion

As paragraph 270-10(1)(c) is not satisfied each of the paragraphs in subsection 270-10(1) of Schedule 2F to the ITAA 1936 are not satisfied. Therefore, the income injection test in section 270-10 is not failed in respect of the proposed scheme.

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