Edited version of your written advice

Authorisation Number: 1013099481450

Date of advice: 28 October 2016

Ruling

Subject: Disregarding a capital gain or capital loss by foreign resident under Div 855 of the ITAA 1997

Summary

Any capital gain made by Trust A from the disposal of its units in Trust B will be disregarded in accordance with section 855-10 of the ITAA 1997. The indirect Australian real property interest held by Trust A in Trust B does not pass the non-portfolio interest test as stated in section 960-195, and therefore, is not taxable Australian property.

Question 1

Will any capital gain made by Trust A from the disposal of its membership interest in Trust B be disregarded under section 855-10 of the ITAA 1997?

Answer

Yes

Relevant facts and circumstances

Trust A

Trust A is a foreign fund established for the pooling of investment by overseas funds. Trust A is a transparent entity and is treated as a non-resident trust for Australian income tax purposes.

The participants in Trust A (Participants) are independent funds and unrelated investors that do not hold any other direct interest in Trust B.

Trust D

Trust D is another fund in which the Participants hold substantial investment. Both the trustee and Trust D are non-residents for Australian tax purposes.

Trust D holds stapled ordinary shares and units on issue in Company E Group. The Company E Group is listed on the Australian Securities Exchange which directly holds units in Trust B.

Trust C

Trust C is a Management Investment Trust and an Australian tax resident. The majority of Trust C units is owned by Trust A. Trust C was formed with the intention that it will be an investment vehicle and centralised investment platform for all Trust A's Australian investments.

Trust B

Trust B is an Australian tax resident unit trust. Trust B holds land and buildings portfolio in Australia.

Units on Issue

Trust B has A Class units and B Class units on issue. Trust A holds 10% of A Class units and nil B Class units. Trust A acquired its A Class units by way of transfer from the original interest holder.

Both the A Class units and B Class units were issued more than 24 months ago and there have not been any changes to the unit holding in Trust B since Trust A became a unitholder.

There will be no change to either the unit holdings or the unitholders up until the time of the proposed transfer.

Joint Owners Committee

As a unitholder with 10% of the A Class units on issue, Trust A has a Majority Representative on the Joint Owners Committee. B Class units are ignored for the purposes of determining entitlement to appoint a representative to the Joint Owner's Committee.

The Proposed Transfer

Trust A will transfer its existing interest of all the A Class units in Trust B to Trust C at market value.

Relevant legislative provisions

● Sub-section 318(2) of the Income Tax Assessment Act 1936 (ITAA 1936)

● Sub-section 318(3) of the ITAA 1936

● Sub-section 351(1) of the ITAA 1936

● Sub-section 351(2) of the ITAA 1936

● Section 104-10 of the ITAA 1997

● Section 855-10 of the ITAA 1997

● Section 855-15 of the ITAA 1997

● Section 855-25 of the ITAA 1997

● Sub-section 960-130(3) of the ITAA 1997

● Section 960-135 of the ITAA 1997

● Section 960-190 of the ITAA 1997

● Section 960-195 of the ITAA 1997

● Section 974-20 of the ITAA 1997

● Section 974-130 of the ITAA 1997

● Section 974-135 of the ITAA 1997

● Section 974-160 of the ITAA 1997

● Section 995-1 of the ITAA 1997

All subsequent legislative references in this Ruling are to the ITAA 1997, unless otherwise stated.

Reasons for decision

CGT Event

Capital Gains Tax (CGT) event A1 happens under section 104-10 if an entity disposes of a CGT asset. CGT event A1 happens to Trust A on the transfer of its A Class units in Trust B to Trust C.

Disregarding a capital gain derived by a foreign resident

Subsection 855-10(1) states that a capital gain or capital loss from a CGT event is disregarded if:

(a) you are a foreign resident, or the trustee of a *foreign trust for CGT purposes, just before the CGT event happens; and

(b) the CGT event happens in relation to a *CGT asset that is not *taxable Australian property.

Section 855-15 sets out following five categories of CGT assets that are taxable Australian property:

1. Taxable Australian real property (TARP),

2. CGT assets that are indirect Australian real property interests and not covered by item 5,

3. A CGT asset used in carrying on a business through a permanent establishment in Australia,

4. An option or right to acquire a CGT asset covered by the above items, or

5. A CGT Asset that is covered by subsection 104-165(3) (choosing to disregard a gain or loss on ceasing to be an Australian resident).

Trust A through its investment in Trust B units holds indirect interest in real property situated in Australia. Section 855-25 defines when a membership interest is an indirect Australian property interest. Subsection 855-25(1) states that:

A *membership interest held by an entity (the holding entity) in another entity (the test entity) at a time is an indirect Australian real property interest at that time if:

(a) the interest passes the *non-portfolio interest test (see section 960-195):

(i) at that time; or

(ii) throughout a 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

(b) the interest passes the principal asset test in section 855-30 at that time.

The principal asset test

Trust B, the test entity, holds part of the land and buildings portfolio in Australia and it passes the principal asset test.

Membership interest

Section 960-135 defines membership interest as each interest or set of interest or each right or set of rights in relation to an entity by virtue of which the interest or right holder is a member of that entity.

A member of a trust (except a public trading trust) in section 960-130 includes a beneficiary, unit holder and an object of the trust.

However, subsection 960-130(3) provides that an entity will not be considered a member of another entity just because the entity holds one or more debt interests in the other entity.

Debt interest

Subsection 974-20(1) provides that:

A *scheme satisfies the debt test in this subsection in relation to an entity if:

(a) the scheme is a *financing arrangement for the entity; and

(b) the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and

(c) the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when:

(i) the financial benefit referred to in paragraph (b) is received if there is only one; or

(ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and

(d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and

(e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil.

Scheme

Section 995-1 defines scheme as:

(a) any ^*arrangement; or

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

An arrangement means

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

The A Class and B Class units issued by Trust B were an arrangement by Trust B to fund the trust and provide for its future activity.

Financing arrangement

A scheme is a financing arrangement for an entity under section 974-130, if it is entered into or undertaken:

(a) to raise finance for the entity (or a *connected entity of the entity); or

(b) to fund another scheme, or a part of another scheme, that is a *financing arrangement under paragraph (a); or

(c) to fund a return, or a part of a return, payable under or provided by or under another scheme, or a part of another scheme, that is a financing arrangement under paragraph (a).

The A Class and B Class units issued by Trust B were an arrangement by which Trust B sought to raise finance (either immediately or in the future). Therefore, their issuance constitutes a financing arrangement.

Financial benefit

A financial benefit in subsection 974-160(1):

(a) means anything of economic value; and

(b) includes property and services; and

(c) includes anything that regulations made for the purposes of subsection (3) provide is a financial benefit;

even if the transaction that confers the benefit on an entity also imposes an obligation on the entity.

The receipt of funds and the right to call on future funds by Trust B in exchange for A Class and B Class units is of economic value to the Trust and accordingly, will be a financial benefit.

Effectively non-contingent obligation

In accordance with subsection 974-135(1):

There is an effectively non-contingent obligation to take an action under a *scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation (see subsections (3), (4) and (6)) to take that action.

Subsection 974-135(3) provides that:

An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a *connected entity of that entity), other than the ability or willingness of that entity or connected entity to meet the obligation.

A Class Units

In the terms of the Trust B constitution for the A Class units, there is no obligation on the part of the Trust to return any amount to the unitholders. However, on winding up of the Trust, or on the redemption of units, a unitholder is entitled to, broadly, its pro-rata share of the realisation of the Fund or the current unit value respectively.

At the time of redemption these values may not be equal to the values received, therefore, there is no effectively non-contingent obligation on the part of the Trustee to return an amount to the Unitholders in respect of the A Class Units.

B Class Units

B Class units may be compulsorily redeemed at a price equal to the amount paid up in the event that the project for which the capital is raised is not proceeded with, provided the redemption would not have adverse duty consequences for any of its existing unitholders. The Joint Owners Committee decided not to proceed with the project, but the Trustee has determined that due to the adverse stamp duty consequences B Class units were not to be redeemed.

These conditions provide sufficient contingencies at the time when the B Class units were issued that there was no effectively non-contingent obligation on the part of the Trustee to return an amount to the unitholders in respect of the B Class units.

Conclusion-membership interest

The Class A and Class B units are not debt interest but are a membership interests in Trust B.

The non-portfolio interest test

An interest held by an entity will satisfy the 'non-portfolio interest test' if the sum of the direct participation interests held by the entity and its 'associates' in another entity is 10% or more at the time of the transfer or throughout a 12 month period that began no earlier than 24 months before the transfer and ended no later than that time.

Both the A Class units and B Class units were issued more than 24 months ago, and on the basis that there have not been any changes to the unit holding in Trust B since Trust A became a unitholder until the proposed transfer time the analysis below is not required to be varied as between the time of transfer and the previous 24 months.

Section 960-195 states that:

An interest held by an entity (the holding entity) in another entity (the test entity) passes the non-portfolio interest test at a time if the sum of the *direct participation interests held by the holding entity and its *associates in the test entity at that time is 10% or more.

Subsection 351(1) of the ITAA 1936 provides that a beneficiary's direct participation interest in a trust is equal to the greater of:

(a) the percentage of the income of the trust represented by the share of the income to which the beneficiary is entitled, or that the beneficiary is entitled to acquire; or

(b) the percentage of the corpus of the trust represented by the share of the corpus to which the beneficiary is entitled, or that the beneficiary is entitled to acquire;

Subsection 351(2) of the ITAA 1936 further provides:

For the purposes of the application of subsection (1) to a trust:

(a) the percentage of the income of the trust represented by the share of the income to which the beneficiary is entitled, or that the beneficiary is entitled to acquire; or

(b) the percentage of the corpus of the trust represented by the share of the corpus to which the beneficiary is entitled, or that the beneficiary is entitled to acquire;

at a particular time (in this subsection called the ``test time'') in a year of income of the trust, is to be worked out by:

(c) ascertaining whichever of the following is applicable:

(i) the income of the trust for the year of income;

(ii) the corpus of the trust as at the end of the year of income; and

(d) assuming that the share to which the entity is entitled, or that the entity is entitled to acquire, at the test time was the same at all other times during the year of income; and

(e) ascertaining the percentage concerned:

(i) at the end of the year of income instead of at the test time; and

(ii) on that assumption.

Trust A's interest in Trust B will satisfy the non-portfolio interest test if its interest including that of its associate in Trust B provides Trust A with an entitlement to 10% or more of the income or corpus of Trust B at the time of the transfer.

Associates of Trust A

The following are associates of a trustee under subsection 318(3) of the ITAA 1936:

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 that 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.

The Participants in Trust A are associates of that entity given that they are each a beneficiary of the Trust A. As stated in the relevant facts and circumstances above, none of the Participants hold a direct participation interest in Trust B. Therefore, the non-portfolio interest test is applied only to the interest held by Trust A in Trust B.

Trust A's direct participation interest

Income entitlement

The Trust B Constitution provides that the distribution of income for both A Class and B Class units is calculated based on the paid-up proportion of each unit relative to the aggregate amount of the paid-up proportion of all units on Issue, taking into account the number of days the units have been held by the unitholder.

The terms set out for A Class and B Class units do not differentiate the entitlement of A Class and B Class units to distributions of income (prior to any redemption of B Class units).Therefore, Trust A's entitlement of the income of the Trust B as a proportion of total income calculated on Trust A's percentage of interest in Trust B is less than 10%

Corpus entitlement

The Trust B constitution provides that in winding up the trust, the trustee, subject to any special rights and restrictions attached to any unit or the direction in writing of all unitholders, will distribute the net proceeds of realisation among the unitholders pro rata in accordance with the relative paid up proportions of the units held by unitholders.

There are no specific rights or restrictions attached to A Class and B Class units. Therefore, the percentage of the corpus of Trust B that Trust A is entitled to is the same as for the income entitlement above, which is less than 10%.

Conclusion - The non-portfolio interest test

Trust A's direct participation interest in Trust B is below 10%, therefore it does not pass the non-portfolio interest test in section 960-195.

Conclusion

Trust A's membership interest in Trust B does not pass the non-portfolio interest test, and therefore is not taxable Australian property. Any capital gain made by Trust A on the disposal of its units to Trust C is disregarded under section 855-10.

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