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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1051233507733

Date of advice: 20 December 2017

Ruling

Subject: Marketplace lending fund

Question 1

Will the Fund be a managed investment trust (MIT) for the purposes of Division 275 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

Will the Fund satisfy the conditions in section 276-10 in order to qualify as an attribution managed investment trust (AMIT)?

Answer

Yes

Question 3

Will the Fund qualify to treat each class of membership interests in it as a separate AMIT in accordance with section 276-20?

Answer

Yes

Question 4

If the Fund makes a choice in accordance with paragraph 276-20(1)(d), is it fair and reasonable to determine the trust components of each Class of Loan Units treated as a separate AMIT by reference to the loan referable to that Class?

Answer

Yes

Question 5

Will interest income derived by the Fund in respect of the loans be on a cash basis rather than on an accruals basis?

Answer

No

Question 6

If Division 230 were to apply to the Fund’s gains or losses from a financial arrangement, would a ‘default event’ on a loan allow the Fund to switch to the realisation method for application to gains or losses relating to that loan where the default has not been remedied within a 30 day period and the Trustee has assessed that it is not reasonable to expect that the payments owing on the loan are to be recovered?

Answer

Yes

Question 7

If Division 230 were not to apply to the Fund’s gains or losses from a financial arrangement, would the Fund be able to classify a loan, at the time of a ‘default event’, as a ‘non-accrual loan’ in accordance with Taxation Ruling TR 94/32 where the Fund has made a bona fide assessment based on commercial considerations that there is little or no likelihood that the accrued interest will be received?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Relevant facts and circumstances

The Fund is a trust which is an unregistered managed investment scheme under the Corporations Act 2001 open to investment by persons who qualify as wholesale clients (as defined in subsection 761G(7) of the Corporations Act 2001) or sophisticated investors (as defined in section 761GA of the Corporations Act 2001) .

The Fund operates what is commonly referred to as a marketplace lending fund.

The trustee of the Fund (the Trustee) is an Australian resident company and holder of an Australian Financial Services Licence and an Australian Credit Licence.

The Trustee enters into loans with Borrowers in accordance with its lending policy.

Through an online marketplace lending platform (the Platform) operated by the Investment Manager, holders of units in the Fund (Unitholders) may obtain an economic exposure to loans. This exposure is obtained via subscription for Units in the Fund (referred to as ‘Loan Units’), the returns on which are calculated with reference to a particular loan.

Applicants (i.e. potential Unitholders) subscribe to the Fund by applying for, and being initially issued with, Cash Units in the Fund.

Unitholders make selections by which they indicate that they are prepared to have an economic exposure to one or more potential loans. The loans in respect of which Unitholders make the selection have not yet been entered into by the Trustee. Prior to being offered to the Unitholders, loans presented for investment via the Platform are assessed and selected by the Investment Manager via a rigorous credit risk process.

As part of its obligations, the Investment Manager will have identified the Borrowers; undertaken credit assessments; facilitated loan application, approval and settlement matters; and negotiated terms of the proposed loans (including the interest rate which the Investment Manager will set in accordance with their risk assessment of the Borrower and market conditions at the time).

If a loan has secured enough successful selections from one or more Unitholders (and all legal documentation and conditions precedent to the loan have been completed/satisfied), the Trustee will lend money equal to the total of all successful selections to the Borrower under the loan agreement. The Fund does not borrow any of the money it lends to Borrowers.

These loans will be secured by a registered first or second ranking Mortgage over real property and made to established Australian project developers, corporates and individuals that satisfy the Fund’s lending guidelines.

The loans will be used by such Borrowers to fund a variety of projects.

The maximum term of a loan will be five years and the minimum term will be six months.

The amount committed to a fully funded loan is held in Cash Units until such time as the loan is drawn down by the Borrower. Just prior to the draw down, the relevant Cash Units held by one or more Unitholder will be redeemed by the Trustee and used to acquire Loan Units of a separate Class in the Fund on the Unitholder’s behalf.

Each Class of Loan Units will be Referable to a particular loan.

The term Referable is a notional concept as Unitholders do not obtain a beneficial interest in any particular loans (or in any particular part of the Trust).

Unitholders will have an equal and undivided interest in the whole of the Fund.

Unitholders holding Loan Units on the last day of a Distribution Period are presently entitled to receive distributions Referable to the loan. These amounts, comprised of both income and capital, constitute Distributable Entitlements.

The distribution of a Unitholder’s Distributable Entitlement, required to be paid on the last day of the relevant Distribution Period, will be via subscription to Cash Units in the Fund. The Trustee’s obligation to distribute the Distributable Entitlement will be set off against the Unitholder’s obligation to pay the Application Price for the issue of a number of additional Cash Units in the Fund equivalent to the value of that distribution.

The Trustee’s obligations to settle unpaid distribution amounts (with Cash Units) owing to Unitholders holding Loan Units are limited to the extent that the principal repayments and interest payments owing by the Borrower in accordance with the loan have actually been received by the Trustee. A Unitholder with Units in one Class is not entitled to income or capital of other Classes of Units in the Fund.

On full repayment of a loan by a Borrower to the Trustee and distribution of all amounts to the Unitholder holding Loan Units Referable to that loan, those Loan Units are redeemed by the Trustee for nil consideration.

A Unitholder may not redeem their Loan Units Referable to a loan during the term of that loan.

A Unitholder may redeem Cash Units at their discretion to the extent that such a withdrawal would not cause the Unitholder’s Cash Unit balance to fall below the amount they have committed to a loan which is yet to be drawn down.

In making a determination or assessment as to the likelihood of any accrued interest and principal being received on a loan, the Fund has a policy of performing periodic reviews and monitoring of its loans in relation to any default events.

The Investment Manager is responsible for overseeing and effecting the enforcement of loans which are in default. The debt recovery and subsequent actions taken by the Investment Manager (on behalf of the Fund) in respect of a loan in default are as follows:

Any loan that is the subject of the above debt recovery process, and still in default, will be classified as a non-accrual loan in the books of account of the Fund.

Assumptions

1. Interest on the loans will (at the very least) be paid on an annual basis and will therefore not constitute an ‘eligible return’ under subsection 159GP(3) of the Income Tax Assessment Act 1936 (ITAA 1936).

2. For the purpose of questions 1 to 5 and 7 of this ruling only, the Fund:

3. The widely held and closely held tests contained in paragraphs 275-10(3)(e) and 275-10(3)(f) respectively will be satisfied for the period after 30 June 2018 (after the start-up period).

4. The Trustee will make a choice under subparagraph 276-10(1)(e)(i) to have the AMIT rules under Division 276 apply as of 1 July 2017.

5. The Trustee will make a choice under paragraph 276-20(1)(d) to treat each class of membership interests in the Fund as being a separate AMIT as of 1 July 2017.

6. The non-payment of interest and/or the non-repayment of principal by a Borrower; and/or a breach of loan covenants; and/or any bankruptcy action against the Borrower during the term of their loan will result in an ‘impairment loss event’ for the Fund under paragraph 59 of Australian Accounting Standards Board (AASB) 139.

7. For the purpose of paragraph 230-185(2)(e), the Fund will prepare financial statements in accordance with the relevant accounting principles.

8. For the purpose of question 6 of this ruling only, the Fund will not apply the accruals method to the overall gain from a loan.

9. The Fund will not invest in assets that are not listed in paragraph 102M(b) of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6C of Part III

Income Tax Assessment Act 1936 paragraph 102M(b)

Income Tax Assessment Act 1936 subsection 159GP(3)

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 section 230-45

Income Tax Assessment Act 1997 subsection 230-45(1)

Income Tax Assessment Act 1997 paragraph 230-45(1)(d)

Income Tax Assessment Act 1997 paragraph 230-45(1)(e)

Income Tax Assessment Act 1997 paragraph 230-45(1)(f)

Income Tax Assessment Act 1997 subsection 230-45(2)

Income Tax Assessment Act 1997 Subdivision 230-B

Income Tax Assessment Act 1997 paragraph 230-100(2)(c)

Income Tax Assessment Act 1997 subsection 230-100(3)

Income Tax Assessment Act 1997 subsection 230-100(5)

Income Tax Assessment Act 1997 section 230-110

Income Tax Assessment Act 1997 subsection 230-110(1)

Income Tax Assessment Act 1997 section 230-115

Income Tax Assessment Act 1997 subsection 230-115(2)

Income Tax Assessment Act 1997 subsection 230-130(3)

Income Tax Assessment Act 1997 section 230-185

Income Tax Assessment Act 1997 subsection 230-185(1)

Income Tax Assessment Act 1997 subsection 230-185(2)

Income Tax Assessment Act 1997 paragraph 230-185(2)(e)

Income Tax Assessment Act 1997 subsection 230-455(2)

Income Tax Assessment Act 1997 subsection 230-455(7)

Income Tax Assessment Act 1997 Division 275

Income Tax Assessment Act 1997 section 275-10

Income Tax Assessment Act 1997 paragraph 275-10(1)(a)

Income Tax Assessment Act 1997 paragraph 275-10(2)(a)

Income Tax Assessment Act 1997 subsection 275-10(3)

Income Tax Assessment Act 1997 paragraph 275-10(3)(b)

Income Tax Assessment Act 1997 paragraph 275-10(3)(c)

Income Tax Assessment Act 1997 subparagraph 275-10(3)(d)(i)

Income Tax Assessment Act 1997 paragraph 275-10(3)(e)

Income Tax Assessment Act 1997 subparagraph 275-10(3)(e)(iii)

Income Tax Assessment Act 1997 paragraph 275-10(3)(f)

Income Tax Assessment Act 1997 paragraph 275-10(3)(g)

Income Tax Assessment Act 1997 subsection 275-10(4)

Income Tax Assessment Act 1997 subsection 275-10(6)

Income Tax Assessment Act 1997 section 275-15

Income Tax Assessment Act 1997 subsection 275-20(1)

Income Tax Assessment Act 1997 subsection 275-20(2)

Income Tax Assessment Act 1997 subsection 275-25(1)

Income Tax Assessment Act 1997 subsection 275-30(1)

Income Tax Assessment Act 1997 section 275-35

Income Tax Assessment Act 1997 section 275-45

Income Tax Assessment Act 1997 section 275-50

Income Tax Assessment Act 1997 section 275-55

Income Tax Assessment Act 1997 Division 276

Income Tax Assessment Act 1997 Subdivision 276-A

Income Tax Assessment Act 1997 section 276-10

Income Tax Assessment Act 1997 paragraph 276-10(1)(a)

Income Tax Assessment Act 1997 paragraph 276-10(1)(b)

Income Tax Assessment Act 1997 paragraph 276-10(1)(e)

Income Tax Assessment Act 1997 subparagraph 276-10(1)(e)(i)

Income Tax Assessment Act 1997 subparagraph 276-10(1)(e)(ii)

Income Tax Assessment Act 1997 section 276-15

Income Tax Assessment Act 1997 section 276-20

Income Tax Assessment Act 1997 subsection 276-20(1)

Income Tax Assessment Act 1997 paragraph 276-20(1)(a)

Income Tax Assessment Act 1997 paragraph 276-20(1)(b)

Income Tax Assessment Act 1997 paragraph 276-20(1)(c)

Income Tax Assessment Act 1997 paragraph 276-20(1)(d)

Income Tax Assessment Act 1997 subsection 276-20(2)

Income Tax Assessment Act 1997 subsection 276-20(3)

Income Tax Assessment Act 1997 subsection 276-20(4)

Income Tax Assessment Act 1997 subsection 276-20(5)

Income Tax Assessment Act 1997 section 276-260

Income Tax Assessment Act 1997 section 276-265

Income Tax Assessment Act 1997 section 276-270

Income Tax Assessment Act 1997 Subdivision 276-F

Income Tax Assessment Act 1997 subsection 995-1(1)

Taxation Administration Act 1953 section 12A-110 of Schedule 1

Corporations Act 2001

Corporations Act 2001 section 9

Corporations Act 2001 section 601EB

Corporations Act 2001 section 761G

Corporations Act 2001 subsection 761G(7)

Corporations Act 2001 section 761GA

Reasons for decision

Question 1

Summary

The Fund will be covered under section 275-50 and will therefore be a MIT for the purposes of Division 275 pursuant to paragraph 275-10(2)(a).

Detailed reasoning

The meaning of a MIT in relation to an income year is provided by section 275-10 as follows –

(1) A trust is a managed investment trust in relation to an income year if any of the following requirements are met:

(a) the trust is covered under subsection (3) of this section in relation to the income year (ordinary case);

(b) the trust is covered under section 275-45 in relation to the income year (only members of trust are managed investment trusts etc.).

(2) A trust is also a managed investment trust in relation to an income year if any of the following requirements are met:

(a) the trust is covered under section 275-50 in relation to the income year (no fund payment made in relation to the income year);

(b) the trust is covered under section 275-55 in relation to the income year (temporary circumstances outside the control of the trustee).

A trust (such as the Fund) that does not satisfy subsection 275-10(3) solely because the trustee does not make a fund payment in relation to the year may nevertheless qualify as a MIT if it is covered by section 275-50 in relation to that income year (paragraph 275-10(2)(a)).

A trust is covered by section 275-50 if the trustee does not make a fund payment during an income year, and the trust would be a managed investment trust (by virtue of its satisfaction of all the other conditions of subsection 275-10(3)) if the trustee had made a fund payment during the income year. Essentially, this provision requires that all the other conditions of subsection 275-10(3) would be satisfied at both the start and end of the relevant income year.

For the purposes of establishing whether the Fund (a unit trust) is a MIT in relation to an income year in accordance with paragraph 275-10(1)(a), by virtue of being covered under subsection 275-10(3) in relation to the income year, it is assessed against each of the conditions set out in that subsection as follows –

(a) at the time the trustee of the trust makes the first *fund payment in relation to the income year, or at an earlier time in the income year:

(i) the trustee of the trust was an Australian resident; or

(ii) the central management and control of the trust was in Australia; and

The Trustee, as trustee of the Fund, is an Australian resident. However, as the Fund will only be distributing interest income during the income year, it will not be making any ‘fund payments’ as defined in section 12A-110 of Schedule 1 to the Taxation Administration Act 1953. Notwithstanding, the Trustee will satisfy this paragraph in accordance with the requirements of section 275-50.

(b) the trust is not a trust covered by subsection (4) (trading trust etc.) in relation to the income year; and

The Fund is not a unit trust covered by subsection 275-10(4), i.e. a trading trust for the purposes of Division 6C of Part III of the ITAA 1936, thereby satisfying the condition in paragraph 275-10(3)(b).

(c) at the time the payment is made, the trust is a managed investment scheme (within the meaning of section 9 of the Corporations Act 2001); and

The Fund is a managed investment scheme within the meaning of section 9 of the Corporations Act 2001, thereby satisfying the condition in paragraph 275-10(3)(c) in the event that the Fund were to make a fund payment in relation to the income year, and in the alternative in accordance with the requirements of section 275-50.

(d) at the time the payment is made:

(i) the trust is covered by section 275-15 (trusts with wholesale membership); or

The Fund is a trust covered by section 275-15, thereby satisfying the condition in

subparagraph 275-10(3)(d)(i) in the event that the Fund were to make a fund payment in relation to the income year, and in the alternative in accordance with the requirements of section 275-50.

(e) the trust satisfies, in relation to the income year:

As the Fund is not a registered managed investment scheme and is covered by section 275-15, it will be required to satisfy subparagraph 275-10(3)(e)(iii).

Subsection 275-10(6) will operate to deem this requirement to be satisfied by the Fund during the start-up period (the income years ending 30 June 2017 and 2018).

Pursuant to assumption 3 of this ruling, the Fund will have at least 25 members during the income years ending 30 June 2019 and subsequent in accordance with the widely-held requirements in subsection 275-20(1), thereby satisfying the condition in subparagraph 275-10(3)(e)(iii) for those years in the event that the Fund were to make a fund payment in relation to the income year, and in the alternative in accordance with the requirements of section 275-50.

(f) the trust satisfies the closely-held restrictions in subsection 275-30(1) in relation to the income year; and

Subsection 275-10(6) will operate to deem this requirement to be satisfied by the Fund during the start-up period (the income years ending 30 June 2017 and 2018). Pursuant to assumption 3 of this ruling, the Fund will satisfy the closely held restrictions in subsection 275-30(1) during the income years ending 30 June 2019 and subsequent, thereby satisfying the condition in paragraph 275-10(3)(f) for those years.

(g) if the trust is covered by section 275-15 at the time the payment is made — it satisfies the licensing requirements in section 275-35 in relation to the income year.

As the Trustee has an Australian Financial Services Licence which enables the provision of financial services to ‘wholesale clients’ (within the meaning of section 761G of the Corporations Act 2001), it satisfies the licensing requirements in section 275-35 in relation to the income year, thereby satisfying the condition in paragraph 275-10(3)(g) in the event that the Fund were to make a fund payment in relation to the income year, and in the alternative in accordance with the requirements of section 275-50.

On the basis of all of the above, the Fund will be covered under section 275-50 and will therefore be a MIT pursuant to paragraph 275-10(2)(a).

Question 2

Summary

The Fund will satisfy the conditions in section 276-10 and qualify as an AMIT.

Detailed reasoning

The conditions that a trust would need to satisfy in order to qualify as an AMIT are contained in section 276-10. In the case of the Fund, the relevant conditions are identified and addressed as follows -

Condition: that the Fund be a MIT in relation to the income year (paragraph 276-10(1)(a))

For the reasons set out in response to question 1 of this ruling, the Fund will be a MIT for the relevant income year pursuant to section 275-10, thereby satisfying the condition in paragraph 276-10(1)(a).

Condition: that the rights to income and capital arising from each of the membership interests in the Fund are clearly defined at all times when the Fund is in existence in the income year (paragraph 276-10(1)(b))

The question as to whether the rights to income and capital arising from the membership interests in a trust are clearly defined is one of fact that will generally be determined having regard to the constituent documents of the trust.

Without limiting the ordinary meaning of ‘clearly defined’, section 276-15 sets out certain legislative safe harbours which apply to provide certainty for common arrangements where the rights to income and capital arising from the membership interests in a MIT would be expected to be clearly defined. The Fund does not come within one of these safe harbour tests.

Where a MIT does not fall within one of the safe harbours, the Commissioner will have regard to the following factors (set out in both the Explanatory Memorandum to the Taxation Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015 and Law Companion Guideline 2015/4) in determining whether the rights to income and capital arising from the membership interests in that MIT will be taken to be clearly defined:

The rights to income and capital arising from the membership interests of each Unitholder in the Fund will (with regard to the above factors) be taken to be clearly defined, thereby satisfying the condition in paragraph 276-10(1)(b), as:

Condition: that either the Trustee of the Fund has made an irrevocable choice to apply the AMIT rules under Division 276 for that income year (subparagraph 276-10(1)(e)(i)), or the Fund was an AMIT for an earlier income year (subparagraph 276-10(1)(e)(ii)).

Pursuant to assumption 4 of this ruling, the Trustee will make a choice under

subparagraph 276-10(1)(e)(i) to have the AMIT rules under Division 276 apply to it as of 1 July 2017, thereby satisfying the condition in paragraph 276-10(1)(e).

On the basis of all of the above, the Fund will qualify as an AMIT under section 276-10 for the income year in respect of which the choice under subparagraph 276-10(1)(e)(i) is made and, pursuant to the operation of subparagraph 276-10(1)(e)(ii), for each subsequent income year in which it satisfies the other requirements relevant to those income years.

Question 3

Summary

The Fund will qualify to treat each class of membership interests in it as a separate AMIT for the purposes of Division 276 (other than Subdivision 276-A) in accordance with section 276-20.

Detailed reasoning

The conditions that an AMIT would need to satisfy in order to treat each class of membership interests in it as being a separate AMIT for an income year for the purposes of Division 276, as per subsection 276-20(2), are contained in subsection 276-20(1). Each of those conditions are identified and addressed in the context of the Fund as follows -

Condition: that the membership interests in the Fund for the income year are divided into classes (paragraph 276-20(1)(a))

The question as to whether an AMIT has more than one class of membership interests is one of fact. Law Companion Guideline LCG 2015/5, at paragraph 13, states the following with respect to the meaning of a class of membership interests

Subsection 995-1(1) specifies that a 'class' of membership interests in a trust exists if the interests have the same, or substantially the same, rights. One class of interest will be distinct from another class if the terms relating to the class of interest provide interest holders of the first class with rights to the income and/or capital of the AMIT that are not substantially the same as those obtained by the holders of interests in the second class.

The following classes of membership interests will be issued by the Trustee in satisfaction of paragraph 276-20(1)(a).

Loan Units

Under the terms of the Constitution, the Fund will issue a separate Class of Loan Units (membership interests) to one or more Unitholders Referable to each underlying loan issued by the Trustee to a Borrower in accordance with a Unitholder’s selection. The rights to income and capital of the Fund attaching to each Loan Unit in a Class will be the same. Each Unitholder holding a Class of Loan Units, based on the value of their successful selection, will potentially have rights distinct from those of each other Unitholder holding other Loan Units.

While this means that it is possible that each Loan Unit Class will have just one member, paragraph 2.31 of the Explanatory Memorandum to the Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015 states that “it is possible for a class to have just one member.”

Cash Units

As the rights attached to the Cash Units held by each Unitholder of the Fund will be the same for all Unitholders, this form of membership interest will, for the purposes of paragraph 276-20(1)(a), constitute a separate class of Units in the Fund.

Condition: that the rights arising from each of the membership interests in a particular class are the same as the rights arising from every other of the membership interests in that class (paragraph 276-20(1)(b))

As outlined above, the Constitution provides for the same rights arising for Unitholders in respect of

thereby satisfying the condition in paragraph 276-20(1)(b).

Condition: each of the membership interests in a particular class are distinct from each of the membership interests in another class (paragraph 276-20(1)(c))

Each Class of Loan Units issued by the Fund to one or more Unitholders will be Referable to an underlying loan. The rights of a Unitholder holding Loan Units in that Class will be separate and distinct to the rights arising in respect of a different Class of Loan Units (Referable to a different loan).

Each class of Loan Units will also be distinct from the class of Cash Units issued by the Fund, thereby satisfying the condition in paragraph 276-20(1)(c).

Condition: that the Trustee (as trustee of the Fund) has made an irrevocable choice to treat each class of membership interests in the Fund as being a separate AMIT for the income year (paragraph 276-20(1)(d))

Pursuant to assumption 5 of this ruling, the Trustee will make a choice under paragraph 276-20(1)(d) to have the AMIT rules apply separately to each class of membership interests in the Fund as of 1 July 2017, thereby satisfying the condition in paragraph 276-20(1)(d).

The choice applies to the income year for which the choice is made and every subsequent income year, and is irrevocable (subsections 276-20(4) and (5)).

On the basis of all of the above, the Fund will satisfy each of the conditions under subsection 276-20(1) and be able to treat each class of membership interests as a separate AMIT for the purposes of Division 276 (other than Subdivision 276-A) for the income year in respect of which the choice under paragraph 276-20(1)(d) is made, and for each subsequent income year provided it continues to satisfy the relevant requirements in those later income years.

Question 4

Summary

If the Fund makes a choice in accordance with paragraph 276-20(1)(d), it is fair and reasonable to determine the trust components of each Class of Loan Units treated as a separate AMIT by reference to the loan referable to that Class.

Detailed reasoning

As provided for in subsection 276-20(2), for the purposes of applying Division 276 (other than Subdivision 276-A) each separate class of membership interests in an AMIT which satisfies each of the conditions set out in subsection 276-20(1) (including the making of the relevant choice under paragraph 276-20(1)(d)) is to be treated as being a separate AMIT for that income year.

For the purposes of Division 276 (and pursuant to subsection 276-20(3)), an AMIT which satisfies each of the conditions set out in subsection 276-20(1) will accordingly allocate assessable income, exempt income, non-assessable non-exempt income, tax losses, net capital losses and other similar amounts in respect of the AMIT between each of the separate classes of membership interests on a fair and reasonable basis.

To work out how much of an amount of a particular character is attributed to each member of an AMIT for an income year, an AMIT must (in accordance with the rules specified in section 276-265 and 276-270 and subject to Subdivision 276-F) first work out the trust component for the income year:

As the entitlements to income and capital for each Class of Loan Units issued in the Fund is determined by reference to a specific asset of the Fund, being a Referable loan, the Fund will be constituted by classes with separately identifiable and referable assets.

LCG 2015/5 provides guidance in respect of AMITs constituting classes with separately identified assets as follows –

35. If a trustee chooses to treat each class of membership interests as a separate AMIT, each class is treated as having separate trust property to the extent that the property can be separately identified for each class.

36. Where there are separately identifiable assets, the assessable income, allowable deductions and other tax attributes for each class need to be determined by reference to the assets supporting that class. To do otherwise would be inconsistent with the rule in subsection 276-20(3) …

For each Class of Loan Units treated as a separate AMIT under subsection 276-20(2), the Trustee should work out the trust components for that deemed separate AMIT for the income year by reference to the loan Referable to that Class.

Question 5

Summary

Interest income derived by the Fund in respect of the loans will be on an accruals basis as it is considered that that basis provides the most substantially correct reflex of the Fund’s income.

Detailed reasoning

The Commissioner’s view on the appropriate basis for accounting for income in respect of an income year is set out in Taxation Ruling TR 98/1. The general approach provided in that ruling is set out at paragraph 17, which states:

TR 98/1 also states that the Commissioner considers that the earnings (accruals) method is the most appropriate basis for accounting for business income from a trading or manufacturing business, or where the business income is not referable to the provision of knowledge or the exercise of skill possessed by the taxpayer in the provision of services (paragraphs 18 and 20).

Where the circumstances of a case do not clearly fall within the descriptions at paragraph 18 and 20 of TR 98/1, the factors set out at paragraphs 52 to 59 of the ruling may assist to determine the most appropriate method.

Whether or not a business is being carried on is a question of fact to be determined with regard to all the relevant circumstances. Paragraph 13 of Taxation Ruling TR 97/11 sets out the principles for determining whether the activities of an entity constitute a business. These factors include:

While no single factor is determinative of whether a business is being carried on, two factors assist ‘in marking out activities as a business: repetition and the existence of a purpose of making a profit’ (FCT v Radnor Pty Ltd 91 ATC 4689 at 4700, per Hill J).

In the current case it is considered that the Fund is carrying on a business which consists of operating a ‘marketplace lending platform’ and the activities associated with raising funds from investors (the Unitholders) and then entering into loans with selected Borrowers. The following factors are indicative that these activities are properly characterised as a business:

The income derived by the Fund consists of interest received on the monies put out on loan. This income is not ‘derived from the provision of knowledge or the exercise of skill possessed by the taxpayer in the provision of services’ (as referred to in paragraph 18 of TR 98/1). The activities of the Fund are more akin to the activities of a trading business than a mere investment.

Furthermore, having regards to the factors at paragraphs 52 to 59 of TR 98/1 it is considered that the earnings basis is the most appropriate basis of accounting for income. The income of the Fund is derived from the laying out of circulating capital and not by the taxpayer’s services (paragraph 54). The Fund has formal procedures associated with the provision of credit and the recovery of amounts that are owed to it (paragraph 57). The Fund accounts for its interest income on an accruals basis (paragraph 59).

As such, it is considered that the earnings (accruals) basis provides the most substantially correct reflex of the Fund’s income.

Question 6

Summary

If Division 230 were to apply to the Fund’s gains or losses from a financial arrangement, a ‘default event’ on a loan would allow the Fund to switch to the realisation method for application to gains or losses relating to that loan where the default has not been remedied within a 30 day period and the Trustee has assessed that it is not reasonable to expect that the payments owing on the loan are to be recovered.

Detailed reasoning

Ordinary application of Division 230 in respect of the loans

Division 230 sets out the tax treatment of gains or losses from a ‘financial arrangement’. Generally, an entity will have a financial arrangement if they have under an arrangement, a cash settlable legal or equitable right to receive a financial benefit, a cash settlable legal or equitable obligation to provide such benefit, or a combination of one or more such rights and/or obligations, and paragraphs 230-45(1)(d) to (f) do not apply (subsection 230-45(1)).

A right to receive or obligation to provide a financial benefit can be cash settlable under subsection 230-45(2) if, inter alia, the benefit is money, it is a right you intend to satisfy or settle by receiving money, or it is an obligation that you intend to satisfy or settle by providing money.

Each loan held by the Fund will constitute a financial arrangement under section 230-45 on the basis that it will have a cash settlable legal right to receive financial benefits from a Borrower, constituted by rights to receive principal repayments and interest payments.

As a consequence, Division 230 will apply in relation to gains or losses from the loans held by the Fund.

Where a gain or loss from a financial arrangement arises from a financial benefit that is to be received or provided under that arrangement and is sufficiently certain before or at the time when the arrangement starts and before the benefit is to be received or provided, or becomes sufficiently certain after the time when the arrangement starts and before the benefit is to be received or provided, the accruals method under Subdivision 230-B applies to the gain or loss

(subsection 230-100(3)).

A sufficiently certain gain or loss from a financial arrangement at a particular time is one that is of a particular amount or at least a particular amount, with regard only to financial benefits that are sufficiently certain to be received and provided (sections 230-110 and 230-115).

A financial benefit that is to be received or provided is treated as sufficiently certain if:

Having regard to the terms of the loans, the amount of the payments/repayments Borrowers are obligated to make to the Fund on a periodic basis over the term of the loans will each be determinable with reasonable accuracy at the time of the making of the loans.

Each payment will therefore be a financial benefit that the Fund is sufficiently certain to receive, and (on the basis of assumption 8 of this ruling that the Fund will not make an election to apply the overall gain or loss method under paragraph 230-100(2)(c)) will constitute a sufficiently certain particular gain of the Fund under subsection 230-100(3).

The characterisation of each individual payment received by the Fund in respect of a loan as a separate gain, and the consequent application of the accruals method of taxation to each such payment, is consistent with the Explanatory Memorandum to the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (the TOFA EM) pursuant to which the taxation of financial arrangements regime was introduced, noting as follows

Where, under the accruals method, the Fund has a sufficiently certain gain from a loan under subsection 230-110(1), the period over which the gain is to be spread in accordance with subsection 230-130(3) is the period to which the gain relates.

Impairment of a loan

Whether the accruals or realisation method is appropriately applied to a gain or loss is only required to be reassessed where, depending on the facts and circumstances of the relevant arrangement, there is a material change in the terms and conditions of the arrangement, or the circumstances affecting the arrangement (subsection 230-185(1)).

A non-exclusive list of changes which are considered to be material changes to the terms and conditions of, or circumstances that effect, a financial arrangement, thus triggering a reassessment, is set out in subsection 230-185(2).

Paragraph (e) of that provision states that a reassessment is required if the financial arrangement is, or includes, a financial asset or financial liability and the taxpayer prepares financial reports in accordance with the Australian accounting standards, or comparable standards, and there is a change to the terms and conditions or the circumstances affecting the financial arrangement, such that the financial asset or financial liability would be treated as impaired for the purposes of those principles or standards.

In this context, the TOFA EM relevantly provides as follows -

A change to the terms or conditions or circumstances that are sufficient to treat a financial arrangement, or a part of the arrangement that is a financial asset or financial liability as impaired

4.233 ... The outcome of the reassessment can result in either the accrual method no longer applying to the financial arrangement and instead the realisation method applying from the time of reassessment, or the impairment requiring a re-estimation of the gain from the financial arrangement. ...

…

4.235 'Impairment' for accounting purposes relates to financial assets where the carrying amount of the asset exceeds its estimated recoverable amount (see paragraphs 58 to 70 of the AASB 139). Objective evidence of impairment is required under AASB 139 before a financial asset is considered to be impaired.

4.236 For tax purposes, under the current law, Taxation Ruling TR 94/32 (Income Tax: non-accrual loans) specifies what would constitute a non-accrual loan for tax purposes. In particular, the taxation ruling refers to indicators which would provide support for a bona fide assessment based on sound commercial considerations, that interest which was previously accrued is not likely to be received (in particular refer to paragraph 47 of the TR 94/32). Such indicators may be relevant in determining if impairment of a loan has occurred, for the purposes of the accounting standards.

4.237 The effect of impairment for the purposes of the reassessment provisions would be that the future gains (represented by interest payments on the loan) would no longer be accrued but instead would be brought to account under the realisation method.

Paragraph 59 of AASB 139 contains a non-exhaustive list of events that would assist in obtaining objective evidence of an impairment event occurring. It provides:

59. A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a “loss event‟) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. It may not be possible to identify a single, discrete event that caused the impairment. Rather the combined effect of several events may have caused the impairment. Losses expected as a result of future events, no matter how likely, are not recognised. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the holder of the asset about the following loss events:

(a) …

(b) a breach of contract, such as a default or delinquency in interest or principal payments;

The non-payment of interest or non-repayment of principal by a Borrower will (as per assumption 6 of this ruling) constitute an impairment loss event for the Fund in accordance with AASB 139. This is because the event will result in a breach of contract, constituted by a default or delinquency in interest or principal payments, as per paragraph 59(b) of AASB 139, and will have a direct impact on the future cash flows otherwise receivable by the Fund.

Secondly, the breach of a loan covenant by a Borrower will (as per assumption 6 of this ruling) constitute an impairment loss event for the Fund in accordance with AASB 139. This is because this event will also result in a breach of contract, constituted by a default or delinquency in interest or principal payments, as per paragraph 59(b) of AASB 139, and may (as to be determined on a case-by-case basis) have a direct impact on the future cash flows otherwise receivable by the Fund.

Thirdly, the Fund’s knowledge of bankruptcy action being taken up against the Borrower will (as per assumption 6 of this ruling) constitute an impairment loss event for the Fund in accordance with AASB 139. This is because the event demonstrates that it is probable that the Borrower will enter bankruptcy or other financial reorganisation, as per paragraph 59(d) of AASB 139, and will have a direct impact on the future cash flows otherwise receivable by the Fund.

On the occurrence of any such impairment loss events for the Fund, the Fund will be required to reassess whether it is appropriate (due to the impairment loss event and pursuant to subsection 230-185(1) and paragraph 230-185(2)(e)) to apply the accruals or realisation method to each payment made in respect of a loan.

To the extent that the reassessment results in any relevant financial benefit no longer being sufficiently certain for the purposes of subsection 230-100(3), the realisation method can be applied to those particular financial benefits in accordance with subsection 230-100(5).

Reassessment of application of accruals or realisation method

In discussing the treatment of a financial benefit that is to be received or provided as one which is sufficiently certain, the TOFA EM notes:

4.99 Both parts of the test are intended to ensure that the taxpayer will only accrue an estimated gain or loss made under a financial arrangement where there is more than a mere expectation that the estimated gain or loss will actually be made - the expectation must be quite firm.

4.100 Requiring the taxpayer to apply the accruals method would be inappropriate where a gain or loss can be estimated but there exists a real possibility that the taxpayer may never make the relevant estimated gain or loss because of the circumstances that may affect whether or not certain financial benefits will actually be received or provided. In this sense, the manner in which contingencies may affect such receipts or payments will need to be considered.

Where one of the impairment loss events described above occurs and has not been remedied within 30 days, the Fund will make an assessment as to whether there will be sufficient certainty as to whether any of the future payments to be made in respect of the relevant loan will be received.

To the extent that the Fund is sufficiently certain that future payments will be received, the accruals method will continue to apply to all of those payments.

However, to the extent that the Fund, having undertaken its assessment, will not have more than just a mere expectation that the future payments to be made in respect of the relevant loan will be received (such that the expectation cannot be described as ‘quite firm’), there exists a real possibility that the future payments to be made in respect of the loan will not be received by the Fund, and therefore sufficient uncertainty as to whether any of those payments will be received.

Accordingly, in reassessing whether it is appropriate to apply the accruals or realisation method to each future payment due to be made in respect of a loan as at the time of the impairment loss event (in accordance with section 230-185), the realisation method will be applied in respect of that loan pursuant to subsection 230-100(5).

Question 7

Summary

If Division 230 were not to apply to the Fund’s gains or losses from a financial arrangement, the Fund would be able to classify a loan, at the time of a default event, as a non-accrual loan in accordance with Taxation Ruling TR 94/32 where the Fund has made a bona fide assessment based on commercial considerations that there is little or no likelihood that the accrued interest will be received.

Detailed reasoning

Taxation Ruling TR 94/32 provides criteria for establishing when a loan made by ‘financial institutions’, as defined in paragraphs 21 to 23 of Taxation Ruling TR 93/27, should be classified as a non-accrual loan for income tax purposes.

Paragraph 5 of TR 94/32 provides that when a financial institution makes a bona fide assessment based on sound commercial considerations that there is little or no likelihood that the accrued interest will be received, the loan can be classified as a 'non-accrual loan' for income tax purposes. Any interest accruing thereafter will not be derived for income tax purposes until it is actually received. The factors that indicate that a bona fide assessment has been made in this regard are set out in paragraph 47 of TR 94/32.

Whilst TR 94/32 applies to financial institutions, its general principles may be applied to other situations involving businesses which account for their income on an accruals basis.

Therefore, where a loan made by the Fund is in default and the Investment Manager, having undertaken the debt recovery and subsequent actions set out in this ruling in respect of that loan, has made a bona fide assessment based on sound commercial considerations that there is little or no likelihood that the accrued interest will be received, the Fund may classify that loan as a non-accrual loan.

Any interest accruing on that loan thereafter will not be derived by the Fund for income tax purposes until it is actually received.

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